piggy bank with flag of Canada

The Bank of Canada is keeping its key interest rate target on hold at 0.25%, but warning it won’t stay there for much longer.

The trendsetting rate has been at its rock-bottom level since March 2020 during the first wave of the Covid-19 pandemic as the economy went into a downturn and three million jobs were lost.

The central bank said Wednesday the rebound since then and especially over the last few months has been stronger than it anticipated.

In a statement, the bank’s senior decision-makers said the economy is running at capacity, including a labour market that is by most standards back at pre-pandemic levels.

The rebound is why it now says it will no longer promise to keep its key policy rate at 0.25%, adding that rates will need to rise to bring inflation back to the central bank’s 2% target.

“Interest rates will need to increase to control inflation. Canadians should expect a rising path for interest rates,” Bank of Canada governor Tiff Macklem said in a statement.

He also pointed to the rapid spread of the omicron variant as an economic “wild card” at home and abroad to explain why the bank held off on hiking rates Wednesday.

“Our approach to monetary policy throughout the pandemic has been deliberate, and we were mindful that the rapid spread of omicron will dampen spending in the first quarter. So we decided to keep our policy rate unchanged today, remove our commitment to hold it at its floor, and signal that rates can be expected to increase going forward,” Macklem said.

CIBC chief economist Avery Shenfeld said he expects the Bank of Canada to raise rates in March if the country gets better news about the omicron variant.

The central bank didn’t outline the timing or pace of increases in its statement, but the decision to hold off on a first hike will be controversial in financial markets at a time when headline inflation is at a 30-year high, said Stephen Tapp, chief economist at the Canadian Chamber of Commerce.

A research note from economists at National Bank Financial called a March hike “effectively a foregone conclusion” now. The economists remained “reasonably confident” in their call for five interest rate increases this year, beginning with consecutive hikes in March and April.

A report from RBC said the next meeting being only five weeks away made it easier for the central bank to hold on Wednesday.

“Holding steady today also allows for a more graceful exit from its forward guidance than if the BoC hiked in January after reiterating its ‘middle quarters of 2022’ guidance in December,” the report said.

The Bank of Canada warned in its updated economic outlook that inflation rates are likely to creep above 5% for the first quarter before easing by the end of the year.

The pace of price growth is then expected to ease by the end of 2022, but inflation for the entire year is forecasted to clock in at 4.2%, up from the 3.4% the bank forecasted in October.

Surveys from the Bank of Canada suggest Canadians are now expecting inflation rates to remain higher for longer.

The longer inflation rates stay high, the more likely Canadians will believe they will stay elevated over the long-term, which the bank worries could lead to runaway price growth.

In the rate announcement, the bank said it will use its policy tools to ensure “near-term inflation expectations do not become embedded in ongoing inflation.”

The central bank estimates the economy grew by 4.6% in 2021, down half a percentage point from its previous forecast in October, and now projects growth in real gross domestic product in 2022 at 4%, down from 4.3%.

The Bank of Canada said part of the downgrade this year is due to the impact of omicron, hints from governments that spending is easing earlier than expected, and supply chain issues that will have “larger and more broad-based negative implications on economic activity” this year.

The bank said the possibility of more variants in the future renewing restrictions here and abroad also cloud the outlook.